Companies often turn to restricted stock units (RSUs) and stock options when compensating and motivating employees with equity-based incentives. Both these instruments are valuable for aligning the interests of employees with those of the company. However, they operate on different principles and have distinct implications for employees. This article looks at what RSUs and stock options are and explores their fundamental differences.
RSUs are a form of equity compensation. They grant employees a promise of future stock shares once certain vesting conditions are met. RSUs are not actual shares; they represent a right to receive company stock later. These units are subject to a vesting schedule. It requires employees to stay with the company for a specific period or achieve predetermined performance goals.
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Stock options allow employees to purchase their company's stock at a fixed price. These options come in two main types: incentive stock options (ISOs) and non-qualified stock options (NQSOs). ISOs have certain tax advantages and are subject to specific eligibility criteria. On the other hand, NQSOs are more flexible but have less favorable tax treatment.
The key differences between restricted stock units and stock options have been discussed below.
RSUs grant employees a stake in the company from the moment they are given, while stock options provide the right to purchase shares in the future at a predetermined price.
RSUs are generally taxed as ordinary income when they vest, whereas stock options can have varying tax consequences depending on whether they are ISOs or NQSOs.
RSUs are less risky for employees because they do not require an upfront investment. On the other hand, stock options can become valuable or worthless depending on the future performance of the company's stock. Employees with stock options bear the risk of a stock's price falling below the exercise price.
RSUs are typically more liquid than stock options. Once RSUs vest, employees usually receive actual shares that they can sell immediately. Stock options require the employee to exercise the option and purchase the shares, which may involve additional costs and potentially tying up capital.
RSUs and stock options are handy for motivating and retaining employees. While they share the common goal of tying employee compensation to company performance, they operate on distinct principles and offer different benefits and risks. Understanding these differences is crucial for companies and employees to make informed decisions about equity-based compensation. Carefully designing and implementing these equity incentives will help companies effectively align their employees' interests with the company's long-term success.